Microsoft Biting the Apple

Microsoft (NASDAQ:MSFT) is waking up to the music. In the latest attempt to capture the fast-growing market of online music the big M is fighting to break the hold Apple's (NASDAQ:AAPL) iPod has on the market. The deal is to join up with a big-name financial company in hopes of making the sale of music more attractive.

Microsoft's MSN music service recently began a free song promotion sponsored by American Express (NYSE:AXP). As a way to attract music junkies, visitors who buy music downloads with their American Express card will receive free songs, while those who apply for an Amex Blue card through a link on the MSN site will get credits to download free music. Ah, buy with plastic, and get free tunes.

Not to be outdone, Apple is also stepping up its marketing efforts. Last month, the company and rock band U2 announced a deal to sell customized iPods. And just in time for the holidays Apple has launched a new iPod store on the front page of Amazon.com (NASDAQ:AMZN). Savvy marketing has helped both the iPod and the accompanying iTunes music store dominate the market, accounting for 70% of all songs bought online. The company now sells more music players than computers, but will profits be eroded by what is sure to be growing competition?

For now, Apple is the undisputed leader in digital music players and online music sales. Microsoft's move into the digital music space has the potential to shake things up. One advantage Microsoft has over the competition is that the company can afford to take a loss on the service until it irons out the kinks. Another is the strength of its Windows Media Audio (WMA) format used by almost all music services, such as Wal-Mart (NYSE:WMT) and Roxio's (NASDAQ:ROXI) Napster. The only exception is the iTunes Music Store, which uses the Advanced Audio Coding (AAC) format. By leveraging its virtual Windows monopoly, the software giant is betting that it can become the de facto standard for downloading music.

However, selling songs is a slim-margin business at best. The player sales are where the profits are counted. Until recently Apple closed its system to competitors; the iPod the only portable music player that works with iTunes, and vice versa. Enter RealNetworks (NASDAQ:RNWK), which has updated software that will let songs downloaded from its own music store Harmony be played on a variety of devices, including the iPod. Apple has called this "hacking," and it is still an issue to be resolved. The strategy to convert the overhead costs from the iTunes Music Store into profits from selling iPods is a debatable long-term strategy.

One fact is clear: Microsoft is looking long term and has the cash to stay the course. Other companies such as Apple are working with dramatically fewer resources. At some point, portable media players will become commodity items, and Apple won't be able to charge customers the high prices it does now. Then the equation will change, perhaps to Bill Gates' advantage.

For related Foolishness check out:

• Meta-Music for the Masses?
• Wake-Up Time for Napster
• Mo' Music From Microsoft
• Waiting on iTunes

Fool contributor Kelvin Taylor does not own shares of any of the companies mentioned.